By Trevor Gurwich - First Quarter 2020
There’s a lot of uncertainty going into 2020. Unresolved tensions between China and the U.S., the continuing Brexit saga and the upcoming U.S. presidential election are all major concerns. Yet I continue to be cautiously optimistic about global small-cap stocks. In fact, I expect small caps to catch up a bit this year if they can post stronger earnings growth than large-cap stocks. My team is looking for opportunities at the company level. Who can continue to grow despite political and trade uncertainty? Find out below.
Large-cap stocks outperformed small caps in 2019, but we think a lot of that valuation has played out. I believe small-cap stocks, on the other hand, are set up to demonstrate stronger earnings growth this year. Paired with more compelling valuations than pricier large caps, I think the outlook for small caps is promising.
Some precursors from 2019 are setting up 2020 well. Interest rates are low, and employment is high. We have the cusp of a Brexit solution that allows more certainty in decision making within Europe. We have at least a first-phase resolution of the U.S.-China trade dispute, which will hopefully give companies enough clarity to understand where and how they’ll spend their capital. Japan also just announced a large infrastructure stimulus designed to support its economy for the next three to five years.
There are several investment themes that may be at inflection points. We think two in particular may provide opportunities through 2022.
The auto sector had a very difficult 2018 and 2019. For example, some European companies had to delay production schedules because of emissions scandals. We’re now starting to see that sector stabilize and production restart from baselines. We are also seeing a move to electric and hybrid vehicles, and we think that’s going to drive a lot of investment in the auto sector.
Another interesting, emerging trend is the 5G smart phone. We think it’s going to persist as an investment theme regardless of geopolitical issues. Apple is not going to stop its 5G plans because of the U.S.-China trade war; they’re going to continue spending. That spending should help the whole production food chain—from inspection and installation equipment to equipment that makes the machines. And that’s where we think we can benefit from an investment perspective.
So, we’re finding a lot of great, stock-specific opportunities around the world. Keep in mind that there might be 10,000 companies in the small-cap universe, but we’re looking for the top 1 or 2%—companies that are going to grow in any type of environment. That’s going to be crucial in a year in heavy with geopolitical influences.
We are fundamental investors. This means we look at each company for its individual merits. But we would be remiss if we didn’t account for the potential risks posed by the U.S. presidential election. The candidates’ platforms have the potential to affect certain sectors, regions or even trading policies, so we try to build our portfolio to take some of those risks into consideration. We want to make sure we’re not overly exposed to vulnerable regions or sectors in an effort to reduce unintended risks.
We believe earnings growth is the number one driver of stock prices. So, there are certainly some areas we’re avoiding in the global small-cap universe because they’re still struggling. These include companies heavily exposed to trade between China and the U.S. They’re having difficulty right now because there’s no clarity.
I do think this trade war is going to continue for a long time, in one format or another. I’m optimistic we’ll slowly make our way into agreements that are better for the relationships of both countries. But remember this is a highly complex negotiation between two very different cultures with very different time horizons. Progress is going to take time.
That’s why we look right at the heart of companies we’re researching to see if they can grow, despite the geopolitical environment. We’re finding a lot of opportunities today in Europe and Asia. There were sectors that struggled in 2018-19 we think are starting to inflect. Ultimately, our goal is to capture that improvement before the broader market recognizes it.
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References to specific securities are for illustrative purposes only, and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.
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